Bottom picking

The current volatility witnessed in asset classes such as equities, bonds, oil, gold, base metals and real estate and synchronised global market movements have left many investors baffled. There has been a lot of panic and investors, analysts and fund managers alike are debating whether this is a bear market or a disguised bear run within an inherent bull market. And, if the answer is the latter, then whether it is a structural bear run or a cyclical one. The common advice that investment experts give is that you should invest for the long term. The BSE Sensex was at around 21,000 in December 2007 and even today, after eight long years, we are still at 23,000. Therefore, what is the relevance of the long term? As economist John Maynard Keynes once observed, “In the long run, we are all dead”.

The basic tenet of investing is that we have to buy good quality companies with decent long-term growth prospects at depressed valuations and this opportunity is presented to us during a great bear market bottom. Russell Napier’s book Anatomy of the Bear is a must-read for any serious student of money and investments. The author identifies certain key traits of a bear run. He dissects the past century in American history and lays out the four great bear markets — 1921, 1932, 1949 and 1982 — that provided investors with excellent buying opportunities and resulted in the markets multiplying several times over the next few years.

How do we identify a great bear market bottom? Napier’s book shows that there are several factors that are common to the great bear market bottoms, such as:

1. Price stabilisation: There is an improved demand for certain goods at lower levels, particularly automobiles.
2. Commodity price stabilisation: There is a stabilisation in commodity prices, which precedes an equity market rally.
3. Reduction in Fed-controlled interest rates: US Federal policy is one of the most powerful tools in determining the equity market bottoms because I think there is no other factor as important for equity valuations as interest rates.  

No matter how advanced our financial systems become and how many financially-engineered tools we have at our disposal, we cannot alter human psychology, we cannot control the madness of the crowd, we cannot change individual irrational behaviour and we cannot change the perception of fear and greed associated with financial decision-making. As proved using historical evidence, markets will only get more volatile in future. In this light, Napier’s book is not something to be read and forgotten; it is an investment classic that has to be applied during every market cycle. I’m sure this book will be just as relevant a hundred years from now as it is currently.